Most financially distressed companies have the same things in common: poor working capital controls and the employment of a reactive working capital management strategy rather than a proactive approach.
Improving the company’s working capital through a proactive strategy can be a quick way to get your head above water without increasing sales or cutting cost. For companies in financial distress, that kind of improvement can be the first step to turning the company around. For healthy companies, the surplus cash flow can be reinvested in ways to create value for customers, be invested in a brand or expand your services or product range.
The process of improving working capital can also highlight improvements in operations such as supply-chain management, human resource management, procurement, sales and non-value-added cost.
The first step is to focus on your income and customers and to ask the how, who and when question. You need to understand exactly how your income is generated, who you will collect it from and when you will collect the income. Once you have established the above, you should focus on collecting all income due to you as soon as possible. This can be done by informing debtors of their balance due, following up on debtors to pay their outstanding balances, offering a discount on early settlement of their account or, as a last resort, taking legal action to recover the balance due.
The focus should be to reduce your debtors’ collection days to as few as possible, while at the same time retaining the customer relationship.
The second step is to focus on your inventory levels. Having a clear understanding of the demand and supply of your product or service is a key factor. You should establish the optimum amount of inventory to sustain your level of demand while maintaining a small buffer for unforeseen circumstances.
The third step is to focus on your expenditure and, more importantly, the supply chain relationships that the company has. Contacting each supplier will allow you to understand the suppliers’ working capital needs and offer specific payment terms that are beneficial to both parties. This is an ongoing process that does take lot of time.
All this will add to reducing your total number of working capital days. That means the number of days it takes you to buy an inventory, manufacture a product, sell the product to the customer and collect your money. Getting this number of days as low as possible will ensure a healthy bank balance and a bottom-line that will put a smile on your face.
There are, however, some risks involved as well. Too little inventory can disrupt operations. Stretching supplier payment terms can leak back in the form of higher prices, if not negotiated carefully, or unwittingly send a signal of distress to the market. But management who are mindful of such pitfalls can still improve working capital by active management and focusing on the constraints.
Working capital is often under-managed simply because of lack of awareness or attention. There is also the possibility that working capital may not be tracked or published in a way that is transparent and relevant to all stakeholders. That almost always indicates an opportunity to improve.
At Hobbs Sinclair, as business rescue practitioners, our first focus is on improving working capital to free up cash flow. This allows us to keep the day-to-day activities running while a long-term strategy can be developed and voted on by creditors in the best long-term interest of the company and all the stakeholders.
In conclusion, working capital is critical to a company’s operations and the financial team within each company needs to take on this responsibility and share it so that it is implemented into every activity within the company.
Hobbs Sinclair Chartered Accountants, a medium-sized financial services firm situated in Claremont, Cape Town, has over 20 years experience. It is owned, managed and directed by two highly qualified and experienced partners in the business and financial services sectors.